The incoherency of American corporate governance and the need for federal standards.

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The incoherency of American corporate governance and the need for federal standards.

INTRODUCTION

On January 17, 2006, Chairman Christopher Cox of the Securities Exchange Commission ("SEC") announced that the SEC would propose extensive revisions to its current rules relating to executive compensation. (1) These rules are now enacted. (2)

"Over the last decade and half," Cox said in his speech, "the compensation packages awarded to directors and top executives have changed substantially. Our disclosure rules haven't kept pace with changes in the marketplace, and in some cases disclosure obfuscates rather than illuminates the true picture of compensation." (3) He added that the rules were "about wage clarity, not wage controls ... [because] the SEC lacks statutory authority to impose salary caps on corporate executives and we'd be out of bounds to attempt that through indirection." (4)

The problem of executive compensation, however, far exceeds disclosure. It involves substantive unfairness of the wages that executives receive, the process used to set their wages, and the inconsistent regulation of corporate governance. (5) Cox's suggestion that the SEC's mandate will not allow it to set wage controls explains his silence on these matters. (6) The SEC, however, already sets wage controls, both directly and indirectly. (7)

Less clear is whether these controls go beyond the SEC's mandate and to what extent new rules could regulate executive compensation. This may mean that the SEC's new rules are an overcautious attempt to stay within its mandate, and will lead to ineffective rulemaking.

This Comment suggests that the U.S. Congress should expand the SEC's mandate so that it has clear authority to implement corporate governance standards. Part I provides an overview of problems regarding how much executive pay is given, how pay is set, and how it is disclosed. (8) It then highlights regulatory responses to those problems, including how they provide contradictory incentives and result in unpredictability and over-regulation. (9) Part II considers the current scope of the SEC's mandate, including courts' and commentators' difficulty in defining its boundaries. (10) Part II concludes that this difficulty sometimes makes the SEC's regulatory actions either ineffective or beyond its mandate. (11) Part III looks at the SEC's recently enacted executive compensation rules and concludes that as a result of the SEC's mandate, the rules will not fix the problems set out in Part I. (12) Last, Part IV argues that the U.S. Congress must expand the SEC's mandate to enable the SEC to set federal corporate governance standards, and to allow it to effectively regulate executive compensation. (13)

I. AN OVERVIEW OF THE EXECUTIVE COMPENSATION DEBATE

Critics of current executive compensation standards have made three broad complaints relating to executive compensation: the pay is too high, the process currently in place for setting compensation is flawed, and executive compensation is poorly disclosed. (14) Regulatory responses to these problems have created mixed results, and in some cases, arguably worsened the problem. (15) Additionally, the many official and unofficial regulatory bodies sometimes provide contradictory incentives that result in unpredictability and over-regulation. (16)

Pay is Too High

Adjusted for inflation, the pay of the average worker remained almost flat at $27,000 from 1990 to 2004, while average Chief Executive Officer ("CEO") pay rose from $2.82 million to $11.8 million. (17) Thus, CEOs now receive about four hundred times the salary of low-ranking employees. (18) This problem affects small to mid-sized companies, as well as larger ones. (19)

Compensation of CEOs at two thousand of the biggest U.S. companies increased thirty percent in 2004, compared with fifteen percent in 2003 and nine and a half percent in 2002. (20) This increase occurred even as company and portfolio values dropped. (21) Corporate assets used to compensate the top five executives at companies grew from less than five percent to more than ten percent of aggregate corporate earnings from 1993 to 2003. (22) Again, many companies have seen CEO pay rise as shareholder returns have gone down. (23)

These figures suggest that, as a percentage of aggregate corporate earnings, pay for U.S. executives is too high compared to the compensation of the average worker, and it is "delinked" to company performance. (24)

Similar studies suggest that pay is too high when compared to executive compensation of foreign counterparts, (25) and when compared to other highly sought after employees, such as sports figures, entertainers, and professionals including attorneys and investment bankers. (26)

There are two counterarguments to the claim that pay is too high. One argument is that even if executives are overpaid, it is not a problem. (27) Many people are not shareholders. (28) Even for those who are shareholders, the amount of value dil...

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